1. KRUGMAN'S MICROECONOMICS for AP* Introduction to Externalities Margaret Ray and David Anderson Micro: Econ: 38 74 Module

2. What you will learn in this Module : What externalities are and why they can lead to inefficiency in a market economy. Why externalities often require government intervention. The difference between negative and positive externalities. The importance of the Coase theorem, which explains how private individuals can sometimes

3. The Economics of Pollution Costs/Benefits of pollution MSC MSB

4. The External Cost of Pollution External Cost – an uncompensated cost that an individual or firm imposes on others Also called a negative externality

5. The Inefficiency of Excess Pollution Q opt MSC and MSB of pollution MSB MSC MSC=MSB Q mkt $1000 Qty of Pollution Emitted (tons)

6. Private Solutions to Externalities The Coase Theorem - so long as property rights are clearly defined, and transaction costs are minimal, a private solution can be found to a situation such as this. Property Rights Transaction costs Ronald Coase For his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy, Ronald Coase received the Alfred Nobel Memorial Prize in Economic Sciences in 1991.

7. Private Solutions to Externalities In reality there might be situations where transaction costs are too high to make a private solution easy to negotiate.In reality there might be situations where transaction costs are too high to make a private solution easy to negotiate. 1. High communication costs between affected parties. Suppose that Bob’s pigs are polluting not just your property, but dozens of other people in the community are feeling the negative impact. Now the costs of negotiating a settlement between dozens of people and Bob are much higher.1. High communication costs between affected parties. Suppose that Bob’s pigs are polluting not just your property, but dozens of other people in the community are feeling the negative impact. Now the costs of negotiating a settlement between dozens of people and Bob are much higher. 2. High legal costs. Negotiations and legally binding agreements might require lots of attorneys and a huge stack of legal bills.2. High legal costs. Negotiations and legally binding agreements might require lots of attorneys and a huge stack of legal bills. 3. Costly delays involved in bargaining. Suppose that Bob is fully aware that you are the victim of the negative externality and decides to delay negotiations and postpones every meeting you have scheduled. Maybe he thinks that you will eventually get tired of these delays and move.3. Costly delays involved in bargaining. Suppose that Bob is fully aware that you are the victim of the negative externality and decides to delay negotiations and postpones every meeting you have scheduled. Maybe he thinks that you will eventually get tired of these delays and move.

8. Figure 74.1 The Socially Optimal Quantity of Pollution Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

9. Figure 74.2 Why a Market Economy Produces Too Much Pollution Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers